Productive borrowing and unproductive borrowing

Borrowing money to finance both business and household spending has been central to the growth of most countries’ economies.

But borrowing can get out of hand, as it arguably has been in the UK since the 1980s, and the results for an economy can be the opposite of what was expected or intended.

Debt and paying it back both have to be manageable and it is clear that for many businesses and households this is not so. Nor should the two be seen as unrelated.

For a business, productive borrowing is when it uses a loan to buy machinery or equipment that will enable it to grow or improve efficiency. Such debt expects to be repaid and contributes to the prospect of being able to pay the money back. Similarly, the householder borrowing for a mortgage would be productive, in that over time this too would be paid back, leaving the owner with a valuable asset.

Unproductive borrowing, such as re-mortgaging a house to increase consumption in the short term or a business loan to pay back debt, becomes a problem when the debt becomes impossible to repay, the situation currently affecting large numbers of over-indebted businesses or households.

The business cannot then finance growth and even if they could, the consumer has little appetite or disposable income to buy.

For some time the banks have been unwilling to lend to SMEs, which have been turning to other avenues for finance. These have included crowdfunding and, according to a recent survey by the software company Sage, more than half the owners of SMEs have been using personal savings or remortgaging their homes to keep their businesses afloat.

This is not a sustainable situation and it is time to accept that finances for many SMEs and households need to be restructured and, like Greece, to address the need for a level of debt forgiveness (creditors taking a “haircut”) to solve the impasse that is inhibiting growth.

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